Clients who want to access the cash value of a whole life or universal life insurance policy present their advisor a complicated array of issues. It is their right, of course, to request a policy loan, partial surrender or even cancel a policy. Whether any of those is in the client’s best interest is a different matter.
A partial surrender, for example, decreases the policy’s death benefit, said Catherine Metzger-Silver, a financial advisor with Edward Jones in Kentville, N.S. Any outstanding policy loan at time of death lessens the death benefit, which may conflict with the client’s long-term financial goals.
“Competing goals are really common when we’re doing this and it’s our job to help clients prioritize what is most important with them,” she said.
When a client considers accessing funds in their life policy, advisors should ask whether the client plans to pay off the policy loan and discuss how it could affect financial goals, said Andrea Frossard, chief commercial officer at Foresters Financial. Make sure they understand the impact that accessing funds can have on their policy’s future growth.
Also, explain that an underfunded universal life policy with a yearly renewable term could be at risk of lapsing, said Jason Szeto, a Sun Life advisor in Bedford, N.S. That can happen if the policy loan plus interest exceeds the policy’s fund and cash value, especially if the money is also used to cover mortality costs..
Szeto said clients need to be advised on the policy’s borrowing rate and funded status.
Both a partial surrender and policy loan are considered partial dispositions, which can have tax consequences for the client. Szeto reminds clients to set aside a portion of the funds so they can meet tax obligations at the end of the year.
Using a policy as collateral
One alternative is to use a life policy as collateral for a loan from a financial institution. That isn’t taxable, and it may provide the policyholder with a lower interest rate than a policy loan.
But it is a more complicated process. “It’s almost like you’re taking out a mortgage,” Szeto said. “There’s definitely more red tape associated with it.”
The policy typically needs to have a larger cash value and clients may have to look outside the Big Six banks to shop for a competitive interest rate, Szeto said.
In addition, policyholders need to be careful that they’re not relinquishing any rights to the policy while it’s assigned as collateral for a loan, Metzger-Silver said. And there’s a chance that the client will lose the policy if they can’t meet loan repayment terms.
“You can’t have it all,” Metzger-Silver said. “Does it make sense for you to take that loan and risk losing the policy?”